So What Is a Financial System?

Before we talk about the financial system, let us talk about money and its origins in Nigeria.

Money has not always been what we now know as money. Different things have served as money over the years, including salt, corn, and rice. In pre-colonial Nigeria, cowries were used as money. Precious metals like gold and silver served as money before the paper money that we all know.

Have you ever thought about what makes money, money?

For anything to be considered money, it must be accepted by everyone as money. Money must also be scarce. If everyone had money, then no one would desire it, and it would no longer be money.

What do you need money for?

Money is used to get other things you do not have. Hence, money is referred to as a medium of exchange. Before money existed, you could only get what you want by exchanging a possession of your own for it. This system of exchange was called barter. You exchanged your yam for someone else's cassava. If you could not find someone with cassava who wanted your yam, then you could not get cassava. Money simplified things by making it possible for you to sell your yam to whoever wanted a yam, and then use the money to buy cassava.

Money is also used as a unit of measurement. Everything you buy is measured in terms of money. A hundred-naira food item is expected to be smaller than a five-hundred-naira food item. A woman who has a million naira in a bank account is considered richer than a woman with just a hundred thousand naira.

Money is also used to store value. You can save a hundred thousand naira in a bank now, and spend it in a year's time. Provided there is no increase in the prices of goods and services (referred to as inflation in economics), your hundred thousand naira will buy almost the same quantity of items one year from now as it would today.

With money, you can buy an item today and pay later. You can buy a phone today for twenty thousand naira and pay in six months' time. This is possible because of the use of money as a store of value.

The financial system exists because of money. So what is the financial system?

The financial system is the process that allows the exchange of money between those who have money and those who do not. Those who have money are called savers or investors in a financial system. Those who do not have money are referred to as borrowers or issuers. Exchange of money in the financial system is done through financial institutions like commercial banks or lenders, investment banks, asset managers, finance houses, and stock exchanges, among others.

Money moves around the financial system from a point of excess or surplus to a point of lack or deficit. So in the financial system, money moves from people and companies that have more money to people and companies that do not have enough money.

Savers or investors supply money to the financial system. Issuers or borrowers demand money from the financial system. Financial institutions act as intermediaries, linking those who have excess money (the supply side) with those who do not (the demand side), in a place called the financial market.

A financial system thus serves these main purposes:

• provides a way for individuals and organisations to pay for goods and services

• ensures money retains value over time

• provides a way for people, organisations, and government to reduce the risk of holding money and also to make some additional money from their investments

• provides a platform for the most efficient use of scarce resources

• provides a way for value to be measured through a pricing system.

Test Your Knowledge

1. What are those on the supply side of the financial system called?

2. What are those on the demand side of the financial system called?

Activity

Find out all the denominations of money in Nigeria. Discuss which denominations are no longer widely accepted by Nigerians and why.

This Is the Financial Market

The financial market is like your local market. The major difference is that in your local market, you only buy items that you can see and touch, like tomatoes or yams. In the financial market, you buy things that you cannot see and touch, like bonds and stocks. These are called financial assets.

As evidence that you own a financial asset in the financial market, you are often given a piece of paper or other form of documentation. For example, when you buy the shares of a company, you are often given a share certificate or an electronic receipt as evidence of your shareholding.

The financial market is where those who lack money meet those who have excess money. People who need money from the financial market include entrepreneurs who are about to start a business, existing businesses, institutions, and governments. Those who have excess money in a financial system include individuals like you and me; institutions; firms set up primarily to invest in other companies, like private equity firms; and even the investment arms of governments.

A financial market is said to be efficient when it provides liquidity. Liquidity is how easily or quickly those who own financial assets can sell them, and how easily and quickly those who want to buy financial assets can find them to buy. If it is easy to buy and sell financial assets, then the financial market is liquid.

Two key requirements of financial markets are;

• Pricing: A financial market provides information about the prices of all financial assets traded in the market. This information is not a secret; it is known to everyone in the financial market. Price is a good indicator of value of a financial asset in the financial market.

• Fairness: A financial market must not only be fair but must also be seen to be fair. Every person trying to buy and sell financial assets in the financial market should be given equal treatment. All participants must be...